Answer to Question #194582 in Microeconomics for Mubashir Ahmed

Question

A special shoe manufacturer ABC Co. has costs of production as follows :

Quantity​​​​0​1​2​3​4​5​6​

Total Variable Cost ($)​​0​50​70​90​140​200​360

 

a. ABC Co.’s fixed costs are $100. Calculate average fixed costs, average variable costs, average total costs and marginal costs at each level of production. (2 Marks)

b. Draw the company’s cost curves in a clearly labelled graph. (1 Mark)

c. The price of ABC shoe is $50. What are the company’s profits? In case of loss, should the CEO continue operations or decide to shut-down? Which would be a wise decision? Explain. (1 Mark)

d. The chief financial officer tells the CEO that it’s better to produce only one shoe this month. What could be the reason for this advice by the CFO? What are the firm’s profits at that level of production? Is this the best decision? Explain. (1 Mark)

Answer 1

Following below is the schedule for the Average fixed costs (AFC), average variable costs(AVC) , average total costs(ATC) and marginal costs(MC) at each level of production.

(b)

Following below are the company's Cost curves:

(c)

The firm should shut down its production.

This is because the firm is making loss at every unit of output produced and hence, cannot cover its costs of production.

(d)

The price of charged by the firm ABC is $50. It is profitable to produce more output when the price is greater than the average cost. 

The average total cost (ATC) which is calculated by dividing the total cost by quantity, is greater than the price charged for all the output level. 

We can see from the table that, the price is lower than the average total cost at each level of quantity. This shows that, it is not profitable to produce in the short-run.

Thus, according to this shut-down rule, the firm should only produce 1 quantity, where the AVC is 50 and equal to the price level which is advised by the CEO. 

The profits at this quantity level would be,

Profits =Total revenue − Total cost

$= (50×1) − (150)$

$=−100$

Profits = Total revenue - Total cost= (50×1) - (150)= -100

This means the firm will only cover cost of variable factor and incur the loss equal to the fixed cost, 100. 

Yes, this is the best decision according to the CEO which is based on the economic principles.